DEATH AND TAXES: FEDERAL TAX LIENS
By: Matthew Evans and Bill Phillips
The age old adage about "death and taxes" continues to hold true. As a lender or finance company, the ability to understand the federal government's power to attach liens upon your borrower's property, aka your collateral, is of the utmost concern. This article provides a brief overview of general areas of legal concern and introduction into federal tax liens.
I. Broad Reach of a Federal Tax Lien
A federal tax lien arises when any person or company fails to make payment after demand by the government of any federal tax. See IRC § 6321. The lien attaches to all property and rights to property of the taxpayer, including property acquired after the tax lien arises and after a Notice of Federal Tax Lien is filed.. This broad concept of "property and rights to property" routinely is interpreted by the courts to include personal property, tangible and intangible property, real property and other rights to property. The concept of "property" is determined under state law, not federal. For example, in many states a liquor license is not property so it is not subject to a federal tax lien.. However, if under state law the taxpayer does have property rights in a liquor license then it is subject to the lien. See Drye v. United States, 528 U.S. 39 (1999). Our advice is that if your customer has a federal tax lien, assume any property you finance under a sale/leaseback or take as collateral in a loan or EFA is subject to the lien. In essence, federal tax liens create a "blanket" lien over all property of the taxpayer.
II. Priority of Federal Tax Liens
Due to the ease at which federal tax liens attach to a taxpayers property, providing adequate assurances that your interest takes priority is critical. To create priority over competing claims the government must file a Notice for Federal Tax Lien ("NFTL"). Similar to a UCC-1 financing statement, a NFTL is a "notice" system to provide for the "first in time, first in right" principle. The majority of states have adopted the Uniform Tax Lien Registration Act, which governs the location of filing for the NFTL. Unlike a UCC-1 financing statement for a business entity, the filing does not occur in the state of organization but rather in the location of the executive principal office. This is important when performing your due diligence in searching for federal tax liens as it can be the difference in taking priority over a federal tax lien. In order to perfect the tax lien on real property, the NFTL must be filed in the real property records in the manner provided under state law - usually in the counties where the taxpayer owns real estate.
Property subject to a federal tax lien also includes transferred and substituted property. If a taxpayer sells property, the tax lien will attach to whatever is substituted for it. If the tax lien is perfected, it can stay attached to property in the hands of a purchaser under varying circumstances. So, even if your borrower has no tax liens, your security interest could be subject to a federal tax lien that follows the asset from the person that sold the equipment to your customer. For the reasons we discuss below, you should generally be fine if the asset is acquired from a vendor or manufacturer in the normal course of business. But keep this in mind if you customer purchases assets from someone selling equipment they have been using, particularly if the seller is a distressed company.
a. Priorities for Interests if Filed Prior to a NFTL IRC § 6323(a) provides, in part, that "the federal tax lien shall not be valid as against any purchaser, holder of a security interest, mechanic's lien or or judgment creditor until notice thereof has been filed." Thus, if a lender perfects its security interest prior to the filing of a NFTL then the lender's claim is entitled to priority over the federal tax lien.
To determine if a party holds a prior valid security interest that takes priority against a federal tax lien one must look to state law. A security interest must be protected under state law as against a subsequent judgment creditor and the holder must have parted with money for a security interest to be valid. See Treas. Reg. § 301.6323(h)-1(a)-3. Additional protection is given to a subsequent holder of a security interest, even if the subsequent holder knew of the federal tax lien, as long as the initial holder's security interest was valid. As always, perfect your security interest so you do not lose priority to liens arising after your transaction, including federal tax liens. If you have any specialized questions on what constitutes a valid "security interest" or other hypothetical please let us know.
Purchasers generally take free and clear of federal tax liens if the sale is completed before the government files a NFTL.. The Internal Revenue Code defines "purchaser" as a person who, for adequate and full consideration in money, acquires an interest (other than a security interest or lien) in property which is valid under state law against subsequent purchasers without actual notice of the federal tax lien. The IRS provides guidance for the term "purchaser." IRS Manual 5.17.12 states, "A purchaser must acquire the property pursuant to a sale which bears a reasonable relationship to the value of the property acquired but does not preclude a bona fide bargain purchase or one who has not completed performance of ones obligations, such as in installment payments." It is worth noting that a holder of a security interest can not qualify as a purchaser. We have been asked by clients looking to help borrowers finance property subject or about to be subject to federal tax liens whether selling the property and leasing it back or otherwise shuffling ownership around will work. The simple answer is "don't try it."
III. Super Priorities over Federal Tax Liens
Contained in the Internal Revenue Code, ten super priorities exist that can prime a federal tax lien even if the Notice of Federal Tax is filed prior to your interest arising. See IRC § 6323. This list includes the purchasers of securities and motor vehicles, retail purchasers and other protected classes. In the event that your transaction falls into more than one category of super priority, the category that gives your interest the greatest protection will apply. Only categories that deal with sale of tangible personal property (e.g., goods) in a non-consumer setting will be discussed below.
a. Purchasers of Motor Vehicles
A purchaser of a motor vehicle can take priority over a federal tax lien. Federal tax liens are not noted on certificates of title; so, the law protects innocent purchasers who purchase a vehicle with a "clean" title. To prime a federal tax lien a "[P]urchaser must at the time of purchase not have actual notice or knowledge of the existence of such lien, and have actual possession of the motor vehicle and thereafter not relinquish possession of the motor vehicle back to the seller or his agent." IRC § 6323 (b) (2). In order to prime the tax lien it is critical that that the purchaser 1) have no knowledge of the lien and 2) take possession of the vehicle. To determine purchaser status, a court will focus on not only the fair market value tendered for payment but also on the facts and circumstances of the transaction as a whole. See Marietta v. United States, 1987 U.S. Dist. LEXIS 15129. Also, never lease the vehicle back to the seller; this will defeat your priority over the federal tax lien.
b. Purchaser at Retail Sale
A purchaser of tangible personal property, such as business equipment, at a retail sale is given a super priority over a federal tax lien unless the purchaser knows or intends that the purchase will hinder, evade or defeat the collection of the federal tax. See IRC § 6323 (b) (3). Retail sale is defined as, "[A] sale made in the ordinary course of the sellers business of personal property of which the seller is the owner. It includes a sale in the retail quantities by a seller who is going out of business but not a bulk sale or an auction where quantities are substantially larger than are customary in the ordinary course of the seller's business or auction where the owner is not in the business of selling such goods. Treas. Reg. § 301.6323(b)-1. For example, if you purchase a computer from a dealership that is subject to federal tax liens, as long as it is made in the ordinary course of business and you do not posses intent to evade the federal tax liens, your interest will prime dealerships federal tax lien.
c. Purchase Money Security Interests
Although not expressly codified in in the Federal Tax Lien Act of 1966, a super priority is given to the holder of a perfected purchase money security interest ("PMSI"). In IRS Revenue Ruling 68-57, the IRS stated, "a purchase money security interest valid under local law given in good faith to secure a loan for the purchase of goods takes priority over a previously recorded Notice of Federal Tax Lien." The critical inquiry for a PMSI is that it is valid under state law. This super priority will prime a federal tax lien and leave your interest with priority. PMSI's generally require an advance of money or credit that enables the debtor to purchase goods and the advance of money is actually used to acquire the specific goods. See UCC § 9-103. To prime a NFTL, the PMSI must still be properly perfected within the statutory period under state law. If the transaction is one in goods (moveable property, such as piece of equipment), the customary routine is filing a UCC-1 financing statement within the statutory time frame from the debtor obtaining the goods, usually 20 days. See UCC § 9-317, 9-324. If these procedures are followed, a federal tax lien will be primed.
EVEN THOUGH SPECIAL PROTECTIONS CAN PRIME A FEDERAL TAX LIEN, IT IS ALWAYS BETTER TO TAKE SEARCH FOR NOTICE OF FEDERAL TAX LIENS BY SEARCHING IN THE STATE OF YOUR BORROWER'S PRINCIPAL EXECUTIVE OFFICE. THESE SEARCHES ARE INEXPENSIVE AND PROTECT YOUR PRIORITY.
Part II - Next Issue:
Special Focus on Motor Madness
 Please note the Internal Revenue Code § 6334(a) provides limited exceptions for exempt property.
 The IRS notes in Manual 5.17.2 that when a sale of property subject to a tax lien occurs, the lien will attach to whatever it is sold for, including cash proceeds. The IRS acknowledges that, as a practical matter, it is difficult to enforce a tax lien upon cash proceeds.
 House of Representatives Report No 1884, C.B. 1966-2 at page 817 (quoting "Although so called purchase money security interests are not referred to under present law, it has generally been held that these interests are protected whenever they arise. This is based upon the concept that the taxpayer has acquired property or a right to property to the extent that the value of the whole property or right exceeds the amount of the purchase money security interest."